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RESEARCH PAPER NO. 868
DO STOCK MARKET RETURNS PREDICT CHANGES TO OUTPUT? EVIDENCE
FROM A NONLINEAR PANEL DATA MODEL
BY
OLAN T. HENRY, NILSS
OLEKALNS & JONATHAN THONG
JANUARY 2003
Department of Economics. University of Melbourne. Melbourne Victoria 3010 Australia
Recent empirical work suggests a predictive
relationship between stock returns and output
growth. We employ quarterly data from a
panel of 27 countries to test whether stock
returns as useful in predicting growth.
Unlike previous research, our approach allows
for the possible non-linear effect of recessions
on the growth-return relationship. There
is strong evidence to suggest that a linear
model would be misspecified and provide
potentially misleading inference. Using
a switching regression approach, we find
evidence that returns are most useful in
predicting growth when the economy is in
recession.
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